The need is to
invest resources into building models based on the best available theory, calibrate
them and then test which of the alternative provides a plausible explanation. It
is not an easy task. It will require combining finance theory, econometrics and
political economy. But it needs to be done.
Notes
1 For the affairs at LTCM see Lowenstein, R. (2000) ‘When genius failed’, The Rise and
Fall of Long Term Capital Management, Random House, New York. The Mexican peso
crisis, which happened in December 1994, was regional and did not grow into a global
crisis as the Asian one did. I am excluding it therefore. There were other national crises
in Russia, Turkey, Argentina and Brazil.
2 For the 1998 debate on financial architecture see Eatwell and Taylor (1998). They
propose a World Financial Authority as a regulator rather than a lender of last resort.
3 For excess volatility see Soros, George (2000) and for overvaluation and persistent bubble
Shiller, R. (2001) Irrational Exuberance, Princeton University Press, Princeton, NJ.
4 Fama, E. (1970) Efficient capital markets: a review of theory and empirical work,
Journal of Finance, 25: 383–417.

…

The social
costs of the public policy responses have been very considerable, usually involving
bail-outs of much of the financial sector and the corporate sector more generally.
There have also been considerable misgivings in East Asia about how differently the IMF responded to the East Asian crises compared to the earlier Mexican
crisis. It is widely believed that the IMF was far more generous in helping Mexico
due to US interest in ensuring that the 1994–95 tequila crisis not be seen as an
adverse consequence of Mexico’s joining the North American Free Trade
Agreement (NAFTA). In contrast, East Asians saw the IMF as far less generous
and far more demanding with them despite having been previously held up as
miracle economy models for emulation by others.
The disappointment has been compounded by the fact that all three countries
had long seen themselves as US (and Western) allies, and hence, expected
favoured treatment instead.

This was the same high-growth and low-inflation “Goldilocks economy” that America enjoyed in the 1990s, only with much faster growth and expanded to a planetary scale, including much of the West. It was a chorus of all nations, singing a story of stable high-speed success, and many observers watched with undiscriminating optimism. The emerging nations were all Chinas now, or so it seemed.
This illusion, which in large part persists to this day, is fed by the fashionable explanation for the boom—that emerging markets succeeded because they had learned the lessons of the Mexican peso crisis, the Russian crisis, and the Asian crisis in the 1990s, all of which began when piles of foreign debt became too big to pay. But starting in the late 1990s, these formerly irresponsible debtor nations cleaned up the red ink and became creditors, even as former creditor nations, led by the United States, began sinking into debt. Thus the emerging nations were poised, as never before, to take advantage of the global flows of people, money, and goods that had been unleashed by the fall of Communism in 1990.

At the low point in mid-1998, the combined stock market value of the key East Asian economies (Thailand, South Korea, Indonesia, Malaysia) was $250 billion, or less than the value of General Electric. Since then the East Asian stock markets have surged tenfold in dollar terms. In retrospect, 1998 offered investors a rare opportunity to buy into those markets.
In all of the regional financial crises going back to the Mexican Tequila Crisis of 1994, the country where the crisis started saw its stock market drop 85 percent on average (for example, Thailand in 1997–1998), while all of the markets in the region fell by an average of 65 percent. Europe is at a similar point today. The Eurozone crisis started in Greece, where the market is up slightly from a maximum decline of 90 percent, and the rest of peripheral Europe—Portugal, Italy, Ireland, and Spain—hit maximum declines that averaged 70 percent.

Yet time and again in recent decades, the world has been gripped by currency contagions, in which investors start pulling money out of one troubled country, triggering a pullout from countries in the same region or income class even though those nations can pay their bills. In a way, the serial crises that have rocked the emerging world since the 1970s are one rolling crisis built on the recurring fear that poor nations won’t have the money to pay their bills. The Mexican peso crisis of ’94 begat the Thai crisis of ’97 begat the Argentine crisis of 2002 and many others, trampling more than a few innocent-victim nations along the way.
At the first signs that one emerging-world currency is faltering—as the Thai baht did in 1997—investors often flee from emerging markets in general. They do not pause to distinguish between countries that face a serious current account deficit problem and those that do not.

…

Instead of anticipating the crisis and making a killing, foreigners sold out at the bottom and lost a fortune.
Capital flight begins with locals, I suspect, because they have better access to intelligence about local conditions. They can pick up informal signs—struggling businesses, looming bankruptcies—long before these trends show up in the official numbers that most big foreign institutions rely on. Balance of payments data show that during Mexico’s “tequila crisis” in December 1994, when the currency peg against the dollar came unstuck, locals started to switch out of pesos and into dollars more than eighteen months before the sudden devaluation. Years later Russians began to pull money out of their country more than two years before the ruble collapsed in August 1998.
Savvy locals are also often the first to return. In seven of the twelve major emerging-world currency crises, locals started bringing money back home earlier than foreigners and acted in time to catch the currency on its way up.

…

I didn’t listen to the chorus whispering, “Kiss of debt, kiss of debt . . .”
Over the last three decades, the world has been subjected to increasingly frequent financial crises, each one setting off a hunt for the clearest warning sign of when the financial mine is about to blow again. Every new crisis seemed to produce a new explanation for crises in general. The postmortems after Mexico’s “tequila crisis” of the mid-1990s focused on the dangers of short-term debt, because short-term bonds had started the meltdown that time. After the Asian financial crisis of 1997–98, it was all about the danger of borrowing heavily from foreigners, because foreigners had suddenly cut off lending to Thailand and Malaysia when their problems became clear. These varying explanations resulted in much confusion and contributed to the general failure of most big financial institutions to see the credit crisis looming before 2008.

For now, there was relative peace in international monetary matters, yet this peace rested on nothing more substantial than faith in the dollar as a store of value based on a growing U.S. economy and stable monetary policy by the Fed. These conditions largely prevailed through the 1990s and into the early twenty-first century, notwithstanding two mild recessions along the way. The currency crises that did arise were nondollar crises, such as the sterling crisis of 1992, the Mexican peso crisis of 1994 and the Asia-Russia financial crisis of 1997–1998. None of these crises threatened the dollar—in fact, the dollar was typically a safe haven when they arose. It seemed as though it would take either a collapse in growth or the rise of a competing economic power—or both—to threaten the supremacy of the dollar. When these factors finally did converge, in 2010, the result would be the international monetary equivalent of a tsunami.

…

Global Skirmishes
Apart from the big three theaters in the currency war—the Pacific (dollar-yuan), the Atlantic (euro-dollar) and the Eurasian (euro-yuan) —there are numerous other fronts, sideshows and skirmishes going on around the world. The most prominent of these peripheral actions in the currency war is Brazil.
As late as 1994, Brazil maintained a peg of its currency, the real, to the U.S. dollar. However, the global contagion resulting from the Mexican “Tequila Crisis” of December 1994 put pressure on the real and forced Brazil to defend its currency. The result was the Real Plan, by which Brazil engaged in a series of managed devaluations of the real against the dollar. The real was devalued about 30 percent from 1995 to 1997.
After this success in managing the dollar value of the real to a more sustainable level, Brazil once again became the victim of contagion.

The preparedness to intervene in currency markets by agreements such as the Plaza Accord of 1985, which artificially lowered the dollar against the Japanese yen, followed shortly thereafter by the Reverse Plaza Accord, which sought to rescue Japan from its depressed state in the 1990s, were instances of orchestrated interventions attempting to stabilize global financial markets.6
Financial crises were both endemic and contagious. The debt crisis of the 1980s was not limited to Mexico but had global manifestations (see Figure 4.2).7 And in the 1990s there were two sets of interrelated financial crises that yielded a negative trace of uneven neoliberalization. The ‘tequila crisis’ that hit Mexico in 1995, for example, spread almost immediately, with devastating effects on Brazil and Argentina. But its reverberations were also felt to some degree in Chile, the Philippines, Thailand, and Poland. Why, exactly, this particular pattern of contagion occurred is hard to explain because speculative movements and expectations in financial markets do not necessarily rely on hard facts.

…

Resistance to the ejido reform was, however, widespread, and several peasant groups supported the Zapatista rebellion that broke out in Chiapas in 1994.19
Figure 4.3 Employment in the major maquila sectors in Mexico in 2000
Source: Dicken, Global Shift.
Having signed on to what became known as the Brady Plan for partial debt forgiveness in 1989, Mexico had to swallow, mainly voluntarily as it turned out, the IMF’s poison pill of deeper neoliberalization. The result was the ‘tequila crisis’ of 1995, sparked, as had happened in 1982, by the US Federal Reserve raising interest rates. This put speculative pressure on the peso, which was devalued. The trouble was that Mexico had earlier taken to issuing dollar-denominated debt (called tesobonos) to encourage foreign investment, and after the devaluation could not mobilize enough dollars to pay them off. The US Congress refused to help, but Clinton exercised executive powers to put together a $47.5 billion rescue package.

…

Menem opened the country to foreign trade and capital flows, introduced greater flexibility into labour markets, privatized state-owned companies and social security, and pegged the peso to the dollar in order to bring inflation under control and provide security for foreign investors. Unemployment rose, putting a downward pressure on wages, while the elite used privatization to amass new fortunes. Money flooded into the country and it boomed from 1992 until the ‘tequila crisis’ spilled over from Mexico:
Within weeks, the Argentine banking system lost 18 per cent of its deposits. The economy that had grown at an average annual rate of 8 per cent from the second half of 1990 to the second half of 1994 fell into a steep recession. Gross domestic product contracted by 7.6 per cent from the last quarter of 1994 to the first quarter of 1996… the government’s interest burden increased by more than 50 per cent from 1994 to 1996.

pages: 354words: 92,470

Grave New World: The End of Globalization, the Return of History
by
Stephen D. King

LATIN AMERICA’S WOES
Following the failure of its currency board at the end of the 1990s – an arrangement in which the peso was supposedly fixed against the US dollar for all time – and its subsequent return to Perónist policies under the Kirchners, Argentina appeared unwilling to subscribe fully to the Western model of faith in free markets and respect for property rights. Argentina, however, was an exception (alongside Venezuela, albeit from a rather different political perspective). Other large Latin American economies were keen to get a slice of the free-market action. Mexico signed up to the North American Free Trade Agreement on 1 January 1994. Although unfortunately timed – Mexico suffered its so-called ‘tequila crisis’ that year – its deal with the US and Canada underscored its enthusiasm for free-market values. Brazil, meanwhile, successfully managed to get a grip on inflation – thanks, in part, to the introduction of the so-called ‘Real plan’ in the mid-1990s. Standing at almost 3,000 per cent in 1990 and 2,000 per cent in 1994, Brazilian inflation badly needed to come down. And it did, dropping like a stone to a low of around 3 per cent in 1998.

…

To be taken seriously by international investors, policymakers in the emerging nations often chose to tie their currencies to US dollars, DM or, more recently, euros: by doing so, they hoped to demonstrate their commitment to monetary stability, even if their domestic financial arrangements appeared to be, at times, rather opaque. Unfortunately, this approach often didn’t work: the apparent guarantee of stability typically encouraged excessive capital inflows, domestic credit booms, unproductive investments and a subsequent rush for the exit. Think, for example, of the Mexican tequila crisis in the mid-1990s, the Asian crisis shortly thereafter, the 1998 Russian debt default, the collapse of Argentina’s currency board at the turn of the century and, most obviously, the global financial crisis.
Given these experiences, an increasing number of emerging nations began to reject currency peg arrangements as a way of advertising their financial probity. Many shifted to floating currency arrangements, aware that attempts to fix foreign exchange rates in a world of free-flowing cross-border capital had only given rise to repeated booms and busts.

First, the Japanese stock market
bubble, in which the Nikkei index tripled in value from 1986 through
early 1990 and then nearly halved in value during the next nine months.
The second was our own Internet bubble that witnessed the NASDAQ rise
fourfold in a little more than a year and then decline by a similar amount
the following year, ultimately cascading some 75 percent.
This same period was peppered with three major currency disasters:
the European Monetary System currency crisis in 1992; the Mexican peso
crisis that engulfed Latin America in 1994; and the Asia crisis, which
spread from Thailand and Indonesia to Korea in 1997, and then broke out
of the region to strike Russia and Brazil. The Asia crisis triggered losses
that wiped out the majority of the market value that the Asian “Tiger”
economies had amassed in the prior decade of booming growth. LTCM
seemed just as cataclysmic at the time, but it centered on a single $3 billion hedge fund in 1998, albeit one that had more than $100 billion at
risk.

Prices drop suddenly because these distressed firms try to obtain cash by throwing inventories on the market dirt cheap. Factories are closed, the continuation of construction projects in progress is halted, workers are discharged.6
That was true not only in the Great Depression, but also in all the severe economic crises that have broken out during the decades following the collapse of Bretton Woods: the Latin American debt crisis of the early 1980s, the Japanese crisis that began in 1990, the Mexican peso crisis of 1994, the Asian crisis of 1997, and the Russian crisis of 1998. When the credit stopped expanding, the depression began.
The current crisis in the United States is no different; when credit ceased to expand, the depression began. This depression, however, has not been allowed to run its course. During the Great Depression, unimpeded market forces purged the economy of the credit-driven excesses of the Roaring Twenties.

Debt continued to grow far faster than Canada could
pay it down. Over the course of Mulroney’s term from 1984 to 1993
debt grew from 46.9 per cent to 67 per cent of GDP.10 At one point,
36 per cent of the taxes of the citizens in Ottawa was going towards
paying off the national debt.11 Even worse, the higher interest rates
were slowing the economy, making it still harder to pay off the debt.
The situation was clearly getting out of control. The 1994 Mexican
Peso Crisis had shown how quickly international investors could lose
faith in a country. Unless Canada acted soon, it too faced the danger
of the vicious cycle of falling investor conﬁdence, increased debt and
economic stagnation. By 1995 Canada’s federal debt was 68.4 per cent
of GDP. On top of this, it also faced provincial debt of 27.6 per cent
of GDP.12 As a whole, the Canadians’ debt had passed an ominous
90 per cent of GDP.

The market stabilized very quickly, and the ink of the magazines warning of a repeat of the Great Depression had hardly dried before the economy had shaken off the stock market crash and was back on track. A hero had been born.
With Greenspan at the helm, the Fed used the same modus operandi whenever crisis loomed: quickly cut the benchmark rate and pump liquidity into the economy. That is what it did at the time of the Gulf War, the Mexican peso crisis, the Asian crisis, the collapse of the Long-Term Capital Management hedge fund, the worries about the millennium bug, and the dot-com crash-and on each occasion, commentators were surprised by the mildness of the subsequent downturn. In someone with Greenspan's clear-cut opinions about the importance of free markets, this readiness to throw money at all problems was surprising. However, to a direct question in Congress about his old laissez-faire views of monetary policy, Greenspan replied, "That's a long time ago, and I no longer subscribe to those views."'

This inaugurated the decade of misery for the developing countries which began with the Mexican debt crisis and lasted through the 1980s. It was eventually resolved by creditors accepting cancellation of debt and the debtor countries selling some of their natural resources in lieu of repayment of the principal.
Mexico was thought to have restored financial prudence and fixed its exchange rates after it had recovered from its debt problem. But in 1994, Mexico was hit by the Mexican peso crisis. Investors from across the world had bought Mexican bonds – the tesebonos. But political turmoil in the Chiapas region led to a panicked withdrawal of capital and a collapse of the peso. The IMF arranged a large loan to help Mexico overcome the shock of the sudden collapse of the currency. This remained a local issue and did not spread beyond Mexico to the US. That, after all, was why the IMF made one of the largest loans it had ever made.

There was a sharp continent-wide recovery in Latin America in the mid-1980s, but it was followed by a downturn. By the end of the decade most countries had conquered hyperinflation and brought sanity to their government finances. The cutting of tariff barriers did spur trade. Countries like Brazil, Chile, and Mexico experienced export booms.
Even as growth strengthened in the 1990s, however, it was still punctuated by financial crises. The “Tequila crisis” in Mexico in 1994 showed that the country was still prone to debt and currency disorders. It provoked a short but very deep recession and required emergency loans of billions of dollars from the United States. The emerging-market panic of 1998, which started in Russia, sparked another bout of capital flight in Latin America, mirroring the debt crisis of 1982 that had provoked the free-market reforms in the first place.

This is
also why liberal economies with freer financial markets emerge
from their crises more quickly. We can compare the rapid recovery
of many Asian states after the Asian crisis with Latin America’s
crisis of the early 1980s, after which Latin American countries
imposed controls on capital outflows and refrained from liberal
reforms. The result was a lost decade of inflation, prolonged
unemployment, and low growth. Compare Mexico’s rapid recovery
after the ‘‘Tequila crisis’’ of 1995 with the same country’s
prolonged depression after the debt crisis of 1982.
Another problem with capital controls is that they are hard to
maintain in a world of ever-improving, ever-faster communication.
They are in practice an invitation to crime, and a great deal
of investors’ time is devoted to circumventing the regulations.
The longer a regulation has been in force, the less effective it
becomes, because investors then have time to find ways around
it.

It was a scary but relatively painless way to learn about making judgments under the pressure of a crisis, about weighing the relative merits of various choices with potentially catastrophic outcomes.
JUST OVER a decade later, I was sitting next to Secretary Rubin in the back of his government car, returning from Capitol Hill during a different kind of crisis.
The secretary had just testified before the House Banking Committee about the Mexican peso crisis, often described as the first financial crisis of the twenty-first century. Mexico was on the brink of defaulting on its obligations, and Rubin had made the case for a $40 billion emergency loan. The reaction was withering. With public opinion running 80–20 against a U.S. government rescue, Republicans and Democrats accused the secretary of plotting to waste tax dollars on foreigners, bail out his Wall Street pals who had speculated in Mexico, and even line his own pockets.

…

A powerful stimulus effort would require a serious mobilization of resources for emerging economies. At an early stage in our internal discussions, Mark Sobel, a veteran Treasury civil servant who held my old international job, and the Fed crisis maven Ted Truman, whom I had recruited to Treasury to help oversee our international efforts, proposed that we should push to expand the IMF emergency fund that we helped create after the Mexican peso crisis. Sobel suggested we try to increase its financing from $50 billion to $300 billion, to make sure it had enough firepower to support countries in trouble.
“Let’s do five hundred billion,” I said. The magnitude of the collapse had been huge, and there was no point in undershooting. Just like that, we decided to propose $500 billion.
At the meeting of finance officials in Horsham, I had pushed to get the major G-20 countries to commit to a substantial fiscal stimulus program; my staff suggested a target of 2 percent of GDP.

(Brazilian government debt is very different from U.S. government debt. It offers high yields, but also high risk. When markets crash, Brazilian debt behaves more like equity than fixed income and usually crashes very fast. Latin American countries have frequently defaulted on their debt, causing large losses on these bonds. For example, after Mexico devalued its currency in December 1994—the so-called Mexican Peso crisis—Brazilian C bonds dropped by 50%.)
LTCM also bought Russian government bonds denominated in Euros. Emerging economies had a history of devaluing their currencies. Debt payable in dollars or Euros was thought to be more secure—if, of course, the country didn’t default altogether.
LTCM’s direct exposure to Russia, Brazil, and other countries was a small part of its portfolio and was not the principal reason for its troubles.

…

This is measured as the average of exports and imports divided by GDP.
8. This is computed by comparing the prices of Greek goods, adjusted for the exchange rate, against 36 other countries. See Eurostat.
9. On the day of the announcement it was revised to 12.7%, but later bumped up again.
10. See Avdjiev et al. (2010).
11. MF Global, for example.
12. The late Rudi Dornbusch, MIT’s famous international economist, said this to a group at MIT after the Mexican Peso crisis, when interest rates were very high and people were considering investing.
13.Helenic Republic Press Release.
14. Even these numbers must be treated cautiously, because much Greek data is suspect.
15.The Greek people voted heavily for the anti-austerity party in the May 6, 2012 elections. In surveys, 70% of the Greeks do not want to leave the Euro, but also don't want the austerity measures.
16.On May 14, 2012, 700 million Euros were removed from Greek banks due to worries about the future of Greece.
17.

This carry trade expanded significantly the Minotaur’s inflows, thus speeding up the financialization process that was to be, paradoxically, the Minotaur’s undoing.
And it was not just the induced crisis in Japan that contributed to the Minotaur’s rapid expansion. Financialization, coupled with repeated attempts to tie domestic currencies to the US dollar (the so-called dollar peg), led to a long chain of financial crises whose ultimate effect was a real economic meltdown in each link of the chain. The chain began in 1994 with the Mexican peso crisis, then moved to South East Asia (with the collapse of the Thai baht, the South Korean won and the Indonesian rupiah), proceeded to Russia and soon ended up back in Latin America (with Argentina being its most tragic victim). All these crises began with a large inflow of cheap foreign capital that led to bubbles in the real estate markets. However, once they burst, a violent outflow of capital, plus a friendly visit by the good people of the IMF, turned these economies into the financial equivalent of scorched earth.

By the end of the Brady Plan in 1993, this semi-voluntary scheme had provided another modest dose of relief, mainly to middle-income Latin American countries like Argentina, Brazil, and Mexico, plus a few U.S. favorites elsewhere like Poland, the Philippines, and Jordan.35 With the help of taxpayer subsidies, the Brady Plan also succeeded in virtually wiping out the debts of a handful of smaller countries—Guyana, Mozambique, Niger, and Uganda. By 1994, just before Mexico’s “Tequila Crisis,” the Brady Plan had yielded about $124 billion (in 2006 NPV dollars) of debt relief, at a cost of $66 billion in taxpayer subsidies. Today, the Brady Plan remains the largest and most costly debt-relief initiative.
Some analysts have argued that the Brady Plan also had an indirect beneficial effect on the quantity of new loans and investments received by debtor countries in 1989-93 because of its impact on equity markets and direct investment.

…

Second, while institutions like the World Bank may be concerned about the impact of debt relief on their debt-financing costs, most ECAs—unlike, say, U.S. savings and loan banks in the 1980s—are fully funded by taxes and don’t have to worry about the impacts of writing down debt.
14. For example, Mexico’s leading banker, Robert Hernandez, purchased Banamex, the country’s second largest bank, from the Salinas government in 1991 for just $3 billion. Over the next decade, he received about $5 billion of financing from the Mexican government that was supposedly invested in the bank. Meanwhile, during the 1994-95 “Tequila Crisis,” former Goldman Sachs partner and U.S. Treasury Secretary Robert Rubin helped to assemble a $30 billion bailout package for Mexico from the World Bank, the IMF, and the U.S. government. Mexico, in turn, used a large share of the money to bail out banks such as Banamex. In theory, these banks should have become the property of the Mexican government again. In practice, owners like Hernandez were permitted to retain their ownership interests without repaying the funds.

But ‘Greater policy space [that is, the ability to use monetary and fiscal policy relatively freely because of strong initial conditions] and better policy frameworks account for the remaining three-fifths of the improvement in their performance.’14
In many respects, emerging and developing countries appear almost to have changed places with the high-income countries in the 2000s. The latter have suffered huge financial crises, big recessions, and correspondingly large rises in fiscal deficits and debt. This is the sort of picture we used to see in emerging and developing countries: one crisis came on the heels of another, notably the Latin American debt crisis of the 1980s, the ‘Tequila crisis’ in Mexico and then other Latin American countries in the mid-1990s, the Asian financial crisis of 1997–98, and the crises in Russia (1998), Brazil (1998–99) and Argentina (2000–01). But emerging countries suffered far fewer banking crises in the 2000s than in the 1980s and 1990s, largely because few had experienced big credit booms in the earlier 2000s. That left them in a good position to expand domestic credit in response to the crises of 2008 and 2009.

…

Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is long past the ocean is flat again.
John Maynard Keynes, Tract on Monetary Reform, 19232
Of all the many ways of organising banking, the worst is the one we have today.
Mervyn King, ‘Banking from Bagehot to Basel, and Back
Again’, 20103
Since 1980, the world has suffered six globally significant financial crises: the Latin American debt crisis of the early 1980s; the Japanese crisis of the 1990s; the Tequila crisis of 1994, whose epicentre was Mexico, but which also affected many parts of Latin America; the East Asian crisis of 1997﻿–99; the global financial crisis of 2007﻿–09; and the Eurozone financial crisis of 2010﻿–13. This list leaves aside many national crises – the 2001 crisis in Argentina, for example – and significant regional crises, including the Scandinavian crisis of the early 1990s. Indeed, one authoritative source estimates there were 147 banking crises between 1970 and 2011.4
Driven by trade and foreign direct investment, economic globalization has produced impressive results, notably the successful integration of China and, to a smaller degree, India, into the world economy, together with large reductions in mass poverty in these and other emerging and developing countries.

This is the misguided idea that all emerging countries are tarred with the same brush, and that if one defaults then inevitably all others in the same category, regardless of their unique situations, will follow suit.
The 1997 East Asian crisis is an illustration of this. Although the financial problems were initially confined to the East Asian economies, countries such as Brazil, where the stock market fell by 24 per cent, and South Africa, where it fell by 23 per cent (both in dollar terms) over the same period, also felt the pain. The Mexican tequila crisis of 1994 and the Russian flu of 1998 are other examples of how the international markets’ negative reactions to one country spill over and unfairly penalize other countries.
In theory, the risk for an African government is that it could be susceptible to its neighbours’ bad news and, without notice, investors could take their money out, leaving a country cash-strapped. With the bond markets effectively shut, a country’s carefully scripted economic plans can be suddenly placed in jeopardy, through no fault of its own.

The generalized slowdown in growth is happening at a time when several economies have already used up some of the considerable resilience they had gained in the run-up to the 2008 global financial crisis—resilience that had served them and the global economy as well.
Having gone through their own internally generated debt and financial crises—and multiple times, including during Latin America’s lost decade of the 1980s, the 1994–95 Mexican tequila crisis, the 1997 Asian crisis, the 1998 Russian default, the 2001 Argentine default, and the 2002 Brazilian crisis—many emerging economies embarked on comprehensive “self-insurance” programs. They involved various combinations of five key items that remain relevant today:
• Building up large financial buffers in the form of ample international reserves;
• Adopting more flexible exchange rates;
• Reducing the currency mismatch between debt issuance and assets/revenues (or what is known by economists as the “original sin”);
• Paying off some debt obligations and refinancing others on more favorable terms, including via longer maturities and lower interest rates; and
• Embarking on institutional changes that render domestic economic management more responsible and responsive.

Despite all the hype about a borderless global economy, the world is still organized around national economies and national currencies; the foreign exchange market is where national price systems are joined to the world market. Problems in the relation between those countries and the outside world often express themselves as currency crises. Two recent examples of this are the European monetary crisis of 1992 and the Mexican peso crisis of 1994. In both cases, one could blame the turmoil on speculators, and one would be partly right — but also in both cases, the political momentum for economic integration had gotten way ahead of the fundamentals. Weaker economies like Italy's and Britain's were being thrust into direct competi-
INSTRUMENTS
tion with Germany's, just as Mexico was being thrown into competition with the U.S.

The idea of public service resonated with Thain, as did the challenge of restoring a national treasure to its former glory. It was in line with a Goldman Sachs tradition in which senior partners left Wall Street for the halls of government. John Whitehead, who led Goldman Sachs in the 1980s, served as deputy secretary of state in the Reagan White House, and Rubin, who joined the Clinton administration, had won wide acclaim for his role in helping to defuse the Mexican peso crisis. Based on his success in Washington, Rubin was recruited to Citibank in 1999 by Sandy Weill to serve as vice chairman, a position that gave him wide-ranging power and a substantial paycheck without the nagging concerns of day-to-day responsibilities at the bank.
A week after his conversation with Reed, Thain called his fellow MIT alumnus to discuss the NYSE opportunity further. It didn’t take long before he accepted the job.

INTRODUCTION
In recent years, hedge funds and commodity trading advisors (CTAs) have
drawn considerable attention from regulators, investors, academics, and the
general public.1 Much of the attention has focused on the concern that
hedge funds and CTAs exert a disproportionate and destabilizing influence
on financial markets, which can lead to increased price volatility and, in
some cases, financial crises (e.g., Eichengreen and Mathieson 1998). Hedge
fund trading has been blamed for many financial distresses, including the
1992 European Exchange Rate Mechanism crisis, the 1994 Mexican peso
crisis, the 1997 Asian financial crisis, and the 2000 bust in U.S. technology
stock prices. A spectacular example of concerns about hedge funds can be
found in the collapse and subsequent financial bailout of Long-Term
Capital Management (e.g., Edwards 1999). The concerns about hedge fund
and CTA trading extend beyond financial markets to other speculative
markets, such as commodity futures markets.

pages: 479words: 113,510

Fed Up: An Insider's Take on Why the Federal Reserve Is Bad for America
by
Danielle Dimartino Booth

Treasury Department in 1988 after three years as an Asia specialist at the consulting firm Kissinger Associates (which later became Kissinger McLarty), his only stint in the private sector.
From 1998 to 2001, Geithner served as undersecretary of International Affairs under both Rubin and Summers, participating in negotiations involving various crises including the bailout of LTCM, the Mexican peso crisis, and the Asian meltdown.
In October 2003, after rotating through positions at the Council on Foreign Relations and the International Monetary Fund (IMF), Geithner was named president of the New York Fed.
Geithner’s appointment was met by snarky rumblings on the Street referring to him as a lackey for Summers and Rubin, the dynamic duo who championed deregulation of the financial system.

Mexico became a member of the OECD and was held up as an example of successful sequencing of economic and political reforms (in contrast to Russia), with perestroika (economic restructuring) coming before glasnost (political opening). As if to reaffirm Mexico’s international prominence, for the first time, a Mexican man, Octavio Paz, won the Nobel Prize for Literature (1990) and a Mexican woman, Lupita Jones, became Miss Universe (1991).
The prestige of the Salinas presidency evaporated with the Zapatista uprising in January 1994, two major political assassinations, the “Tequila Crisis” of December 1994, the first month of Ernesto Zedillo’s sexenio (1994–2000), and the incarceration of Salinas’s brother Raúl in 1995. But Mexico recovered rapidly with the help of a massive US-assisted bailout and continued to consolidate economically and politically under Zedillo. NAFTA led to an immediate increase in average foreign direct investment from US$5 billion to US$13 billion per year, and an average GDP growth (following the crisis year of 1995) of 5.5 percent for the rest of the sexenio.
2000—The Fox Revolution
Sooner than anyone anticipated, perestroika led to glasnost.

By October of 2002 the NASDAQ was back where it had been in 1996. In 2010, Time Warner quietly spun off AOL for a tiny fraction of its price a decade before.
The dot-com crash was preceded by the Asian financial crisis, with subsidiary bubblettes from Russia to Brazil, when a surge of money into promising “emerging markets” abruptly went into reverse. Similar dynamics caused investors to pummel the Mexican peso during the tequila crisis a few years before. Japan’s Nikkei 225 stock index tripled in real terms between January 1985 and December 1989, only to fall 60 percent over the next two and a half years.
The very concept of a financial bubble is three hundred years old, added to the vernacular of finance in 1720 when French, Dutch, and British investors succumbed to euphoria over the potential of new trade routes across the Atlantic—pushing up stock prices before they ended in a precipitous crash.

In the late 1980s, the Savings and Loan (S&L) companies in the US – also known as ‘thrifts’ – got into massive trouble, having been allowed by the government to move into more risky, but potentially higher-yielding, activities, such as commercial real estate and consumer loans. The US government had to close down nearly one-quarter of S&Ls and inject public money equivalent to 3 per cent of GDP to clean up the mess.
The 1990s started with banking crises in Sweden, Finland and Norway, following their financial deregulations in the late 1980s. Then there was the ‘tequila’ crisis in Mexico in 1994 and 1995. This was followed by crises in the ‘miracle’ economies of Asia – Thailand, Indonesia, Malaysia and South Korea – in 1997, which had resulted from their financial opening-up and deregulation in the late 1980s and the early 1990s. On the heels of the Asian crisis came the Russian crisis of 1998. The Brazilian crisis followed in 1999 and the Argentinian one in 2002, both in large part the results of financial deregulation.

It was Europe’s turn in the early 1990s, when currency traders successfully speculated against the central banks of several European countries (such as England, Italy, and Sweden). These countries had tried to limit currency movement by tying their currencies closely to the deutschmark, but financial markets forced devaluations on them. The mid-1990s saw another round of financial crises, the most severe of which was the “tequila crisis” in Mexico (1994) brought on by a sudden reversal in capital flows. The Asian financial crisis followed in 1997–98, which would then spill over to Russia (1998), Brazil (1999), Argentina (2000), and eventually Turkey (2001). These are only the better-known cases. One review identified 124 banking crises, 208 currency crises, and 63 sovereign debt crises between 1970 and 2008.28 After a lull in the early years of the new millennium, the subprime mortgage crisis centered in the United States triggered another powerful set of tremors, confronting financially open economies with a sudden dearth of foreign finance and bankrupting a few among them (Iceland, Latvia).

Given that many profit-hungry US companies chose to invest all over the world – including its emerging parts – this is a remarkable and historically unprecedented result. Partly, it reflects the increasing instability of the financial system as a whole. Following the collapse of the Berlin Wall, crisis layered upon crisis: an early 1990s credit crunch, the 1992 European exchange-rate crisis, the Mexican ‘tequila’ crisis, the Asian crisis, the Russian and Argentine defaults, the dot.com bubble and subsequent bust, the sub-prime crisis and, of course, the global meltdown that followed.
Figure 4.1: 10-year returns for US government bonds and US equities
Source: HSBC
Figure 4.2: 10-year annualized returns across developed and emerging nations
Source: HSBC. Returns data for the ten years to 2000 are not available for Brazil and China and, hence, for the emerging nations as a whole.

Table 3.2 shows some of Argentina’s recent macroeconomic performance indicators. Inflation declined sharply from the hyperinflation
years 1989–90, but the 1990s were characterized by a strikingly high variability of real GDP growth. The economy grew rapidly in the years immediately following the institution of convertibility in 1991. In 1995,
however, the Argentine financial system was badly affected by Mexico’s
“Tequila” crisis (Baliño and others 1997 describe how the Argentine
authorities coped with heavy deposit withdrawals while maintaining
convertibility). After a recovery in 1996 and 1997, Argentina’s economy
went into a protracted recession in 1998. Heavy external debt was a major
contributor and the onset of the East Asian, Russian, and Brazilian financial crises compounded Argentina’s difficulties. Per-capita real GDP and
nongovernment consumption both declined sharply after 1997.

Emerging markets proved popular; Latin America, Asia and Eastern
Europe all had their moments. High returns available on local currency
securities enticed investors to dabble in exotic currencies and high credit
spreads on dollar denominated securities encouraged them to take on
exotic credit risk. Derivatives facilitated investor access and allowed them to
gain exactly the kind of exposure to the market they wanted. In 1995,
Mexico experienced the Tequila crisis. In 1997, the Asian century was still-
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born. In 1998, Russia defaulted. In 2001, Argentina completed its transition from first world to third world economy under the weight of debts
that the country would never be able to service, let alone repay.
Credit derivative products emerged. Credit default swaps and collateralized debt obligations (CDOs) allowed investors to take on credit risk.

With Jason Furman, who would later go on to be the chairman of President Obama’s Council of Economic Advisers, I wrote a paper trying to understand the factors contributing not only to the East Asia crisis but to crises more generally: “Economic Crises: Evidence and Insights from East Asia,” Brookings Papers on Economic Activity No. 2, September 1998, pp. 1–114 (presented at Brookings Panel on Economic Activity, Washington, DC, September 3, 1998).
And also with three World Bank colleagues—Daniel Lederman, Ana María Menéndez, and Guillermo Perry—I wrote a couple of papers trying to understand the Mexican crisis of 1994–1995: “Mexican Investment after the Tequila Crisis: Basic Economics, ‘Confidence’ Effect or Market Imperfection?,” Journal of International Money and Finance 22, no. 1 (February 2003): 131–51; and “Mexico—Five Years After the Crisis,” in Annual Bank Conference on Development Economics 2000 (Washington, DC: World Bank, 2001), pp. 263–82. Finally, with two other World Bank colleagues—William R. Easterly and Roumeen Islam—I wrote two papers trying to understand the forces underlying economic volatility: “Shaken and Stirred: Explaining Growth Volatility,” in Annual Bank Conference on Development Economics 2000 (Washington, DC: World Bank, 2001), pp. 191–212; and “Shaken and Stirred: Volatility and Macroeconomic Paradigms for Rich and Poor Countries,” in Advances in Macroeconomic Theory, ed.

As these decisions lead to volatility, an
economy should not be looked at as a machine-like system operating at equilibrium,
but more like an ecology where actions, strategies, and beliefs compete simultaneously
creating new behaviours in the process. In other words, an economy is always forming
and evolving, and not necessarily in equilibrium.
See “A Failed Philosopher Tries Again.”
(i) LatAm sovereign debt crisis - 1982, (ii) Savings and loans crisis - 1980s, (iii) Stock market
crash - 1987, (iv) Junk bond crash - 1989, (v) Tequila crisis - 1994, (vi) Asia crisis - 1997 to 1998,
(vii) Dotcom bubble - 1999 to 2000, (viii) Global financial crisis - 2007 to 2008.
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Chapter 4 ■ Complexity Economics: A New Way to Witness Capitalism
Secondly, we need to consider the relationship between technology and the
economy, for while the economy creates technology, it is also created by technology,
as has been explained earlier. The impact of technolgy on the economy has also been
discussed in a number of recent works such as Brynjolfsson’s and McAfee’s Race Against
the Machine (2011).

pages: 464words: 139,088

The End of Alchemy: Money, Banking and the Future of the Global Economy
by
Mervyn King

Part of the reason for the extent of the world economic collapse of 1929 to 1933 was that it was not just one crisis but, as I describe, a sequence of crises, ricocheting from one side of the Atlantic to the other, each one feeding off the ones before, starting with the contraction in the German economy that began in 1928, the Great Crash on Wall Street in 1929, the serial bank panics that affected the United States from the end of 1930, and the unraveling of European finances in the summer of 1931. Each of these episodes has an analogue to a contemporary crisis.
The first shock—the sudden halt in the flow of American capital to Europe in 1928 which tipped Germany into recession—has its counterpart in the Mexican peso crisis of 1994. During the early 1990s, Mexico, much like Germany in the 1920s, allowed itself to borrow too much short-term money. When U.S. interest rates rose sharply in 1994, Mexico, like Germany in 1929, found it progressively harder to roll over its loans and was confronted with a similar choice between deflation or default.
There are, of course, differences. Germany in 1928 was much larger compared to the world economy—about three times the relative economic size of Mexico in 1994.51 But the biggest difference was to be found in the management of the crisis.